The China Banking Regulatory Commission issued detailed regulations on local asset management companies, suggesting it will allow the establishment of provincial asset management companies to deal with bad assets. But the proposal may lack practicability, says an article in the 21st Century Business Herald. Excerpts:

As tens of trillions of loans from 2009 are now being paid back to the banks, the expectations of Chinese banks regarding sour assets are high.

The Ministry of Finance and the CBRC issued a joint notice empowering provincial governments to establish or authorize one asset management company to participate in the process in each province, and the central authorities ordered provinces to not transfer bad assets out of the province.

The logic behind the arrangement is that the central authority will no longer take responsibility for provincial bad assets. The problem is that most creditors of local governments are financial organs controlled by the local governments. No matter how the debts are processed, the overall debt level of local governments will not be changed, because local governments are debtors and creditors at the same time.

As provincial governments are mostly debt ridden, the provincial asset management companies, if established, may not have enough financial power to absorb the bad assets of the provinces. More importantly, the provincial governments do not have independent creditor’s rights or the channels to deal with bad assets.

If the local governments experience a debt crisis, the crisis will quickly affect the local financial organs controlled by the governments. The provincial governments will resort to borrowing from the central government to solve their liquidity problems, causing an excessive issuing of currency at the national level.

China should develop its asset transfer and professional risk market to put the bad-asset risks under control through market and professional means, such as the financial tools that turn assets into securities.

In a word the institution in charge of managing debt should not be the debtor and creditor at the same time. Bad debt is accumulated through non-market means. The process of managing bad debt should not repeat the same old path again.